Sri Lanka market interest rates drop after rate cut

May 14, 2013 (LBO) – Sri Lanka’s market interest rates has eased down with the effective policy rate settling at around 7.8 percent though cash auctions down from around 8.3 percent before a 50 basis point rate cut last week, dealers said. On Tuesday gilt backed overnight repurchase transactions were quoted 8.30/40 percent levels in the interbank market down from 8.60/70 levels last week. Call money which is uncollateralized, was down to about 8.60/90 levels from 8.90/9.00 percent levels.

On Friday markets were short and some banks borrowed from the 9.0 percent standing facility keeping rates elevated, after the Central Bank lowered its policy corridor by reducing the standing facilities by 50 basis points to 7.0 and 9.0 percent.

Rates started to adjust from Monday as markets liquidity increased and the Central Bank withdrew money though a repo open market auction at 7.83 percent, effectively setting a new policy signal rate within the standing facility corridor.

One year Treasuries were quoted around 10.60/70 percent in the market Tuesday down from the 11.29 percent auction average last week.

A 3-year bond maturing on 01 April 2016 was quoted at 10.75/85 percent down from 11.22/28 percent last week, a 4-year bond maturing on 15 July 2017 was quoted at 10.70/78 percent.

A 5-year bond, maturing on 01 April 2018 was quoted at 10.90/95 down from 11.30/33 percent.

There were no market quotes for a 2-year bond maturing on 15 March 2015 early Tuesday.

In forex markets the rupee was quoted around 126.30/40 to the US dollar.

Dealers say exporters have stopped selling forward after the rate cut and forward volumes have dropped.

Forward rates rose last month after some banks which borrowed abroad sought to cover their exposure in the market with exporters sometimes selling one year forward.

From late April the weighted average overnight rate climbed slightly as the Central Bank sold down its Treasury bill stock.

In Sri Lanka, where the Central Bank intervenes extensively in forex and Treasury bill auctions, a rate cut is not necessarily generate inflation or currency depreciation.

A rate hike also does not prevent inflation if the monetary authority continues to purchase Treasuries outside the open market operations.

By slowly selling down small volumes of its Treasuries stock, the monetary authority can keep overall policy tight even as rates are cut to encourage credit, analysts say.

Policy can also be made ‘tight’ by allowing the exchange rate to appreciate gently.

Sri Lanka’s bank lending rates have been high mainly due to heavy state borrowings, in 2013 even as credit to private businesses slowed and excess liquidity built up in money markets from Central Bank’s attempts to stop the rupee from appreciating by purchasing dollars.

Loss-making state enterprises have been key borrowers from banks crowding out private businesses engaged in productive activities.